If you lose a job, switch employers, or step into retirement, you might consider rolling your retirement plan savings into an IRA. But this isn't your only option; it could make more sense to keep the money in your previous employer's plan or move it to your new employer's plan (if allowed by the plan).
You could also cash out, but that's rarely a good idea. Withdrawals from tax-deferred retirement accounts are taxed as ordinary income, and you could be hit with a 10% tax penalty if you are younger than 59½, unless an exception applies.
Some employer plans permit in-service distributions, which allow employees to take a partial distribution from the plan and roll the money into an IRA. When deciding what to do with your retirement assets, be aware that IRAs are subject to different rules and restrictions than employer plans such as 401(k)s.
What IRAs Have to Offer
There are many reasons to consider an IRA rollover.
Investment choice. The universe of investment options in an IRA is typically much larger than the selection offered by most employer plans. An IRA can include individual securities and alternative investments as well.
Retirement income. Some employer plans may require you to take a lump-sum distribution when you reach the plan's retirement age, and your distribution options could be limited if you can leave your assets in the plan. With an IRA, there will likely be more possibilities for generating income, and the timing and amount of distributions are generally your decision [until you must start taking required minimum distributions (RMDs) at age 72].
The Top Five Most Common Reasons People Rollover an IRA
69% | They didn't want to leave assets with their former employer. |
65% | Wanted to preserve tax treatment of savings. |
57% | They wanted to consolidate assets |
55% | They wanted more investment options |
44% | They were required to remove the money from their former employer's plan |
Source: Investment Company Institute, 2021 (more than one reason allowed per respondent)
Account consolidation. Consolidating your investments into a single IRA may provide a clearer picture of your portfolio's asset allocation—making it easier to adjust your holdings as needed and calculate RMDs.
Different exceptions. There are circumstances when IRA owners may be able to withdraw money penalty-free before age 59½, options that are not available to employer plan participants. First-time homebuyers (including those who haven't owned a home in the previous two years) may be able to withdraw up to $10,000 (lifetime limit) toward purchasing a home. IRA funds can also be withdrawn to pay qualified higher-education expenses for yourself, a spouse, children, or grandchildren. If you're unemployed, IRA funds can be used to pay health insurance premiums.
When to Think Twice
Some people may have advantages to leaving the money in an employer plan.
Specific Investment Options
Your employer's plan may offer investments not available in an IRA, and/or the costs for the investments offered in the plan may be lower than those provided in an IRA.
Stronger Creditor Protection
Most qualified employer plans receive virtually unlimited protection from creditors under federal law. Your creditors cannot attach your plan funds to satisfy your debts and obligations, regardless of whether you've declared bankruptcy. On the other hand, IRAs are generally protected under federal law (up to $1,362,800) only if you declare bankruptcy. Any additional protection will depend on your state's laws.
An Opportunity to Borrow from Yourself
Many employer plans offer loan provisions, but you cannot borrow money from an IRA. The maximum amount that employer plan participants may borrow is 50% of their vested account balance or $50,000, whichever is less.
Penalty Exception for Separation from Service
Distributions from your employer plan won't be subject to the 10% tax penalty if you retire at age 55 or later (age 50 for qualified public safety employees). There is no such exception for IRAs.
Postponement of RMDs
If you work past age 72, are still participating in your employer plan, and are not a 5% owner, you can delay your first RMD from that plan until April 1, following the year you retire.
Ready to discuss the pros and cons of an IRA rollover with an expert? Connect with a CFS Financial Advisor today and set your no-cost, no-obligation appointment.